(Drivebycuriosity) - The US stock market is on a tear again. The SP 500, the gauge for the US stock market, gained 9% year-to-date, the technology biased Nasdaq climbed even 21%.
The rally is driven by 2 tailwinds:
(source )
1. Inflation rates are dropping - creating hope for falling interest rates in the coming months. High inflation & rising interest rates had caused last year´s bear market.
But inflation peaked already June 2022 with 9.1% and dropped to 4.9%. The high inflation has been caused by a flood of money in the past. In 2020 & 2021 the US government flooded the economy with stimulus checks in the value of trillions of dollars (American Rescue Plan), supported by huge bond purchases by the Federal Reserve.
The government money landed directly on the bank accounts of the Americans, blowing up the money volume M2 (bank notes & coins & deposits at banks).
(source )
Over two years the US money volume M2 jumped about 40% as a result (the charts above display a huge hunchback fred.stlouisfed). The money deluge met a constraint supply of goods & services, partly because of Covid19. It is no surprise that prices had to increase so much (marginalrevolution).
But monetary growth peaked already in February 2021 (with plus 27%). Since then the monetary growth rates have been falling and turned negative in December 2022. In the recent months the money supply has been shrinking! "We have never seen money taken out of the economy like this in our history" ( twitter.com).
Causal Connection
The causal connection between money and inflation is known since the 16th century at least. Nicolaus
Copernicus described already in the year 1522 how "too much money"
causes inflation. Copernicus` "quantity theory of money" is based on
observations:
The Spaniards had conquered today`s Latin America and looted the silver stocks. They send the precious metal to Europe where is was printed into coins and used as money. As a result the European money volume jumped, meeting a restrained supply of goods (agriculture, hand works) & services. The flood of money raised suddenly the demand for scarce goods & services and caused a jump of the price level.
Elaborated studies by Milton Friedman, Karl Brunner, Allan Meltzer and many other economists (known as Monetarists) described already in the 1960s how and why the inflation rate follows the growth rate of money with a time lag (causal connection).
Since inflation follows the growth of money, the inflation rate (growth rate of prices) will follow the pull of the shrinking money volume and the inflation rate will continue to drop.
I expect that the inflation rate - which already dropped 4.2 percentage points - will drop to 2% - the target of the Federal Reserve - and the interest rates will follow and stimulate the stock market further.
Foundation For A Significant Acceleration
2. The secondtail wind is generated by Artificial Intelligence (AI). Microsoft, Google, Amazon and other technology companies are developing and training large language models such as ChatGPT, “which are vast systems based on deep neural networks that have been trained on massive amounts of data and can then be adapted to perform a wide range of different tasks" (brookings ).
These software systems will not only foster revenues & profits of the leading AI corporations. A Brooking study claims that "large language models such as ChatGPT are emerging as powerful tools that not only make workers more productive but also increase the rate of innovation, laying the foundation for a significant acceleration in economic growth" ( brookings).
Baidu, the leading Chinese search engine, declared recently that their AI system will "power agricultural enterprises to promote innovation and to optimize energy use, resource allocation, and waste reduction, and to improve disease diagnosis in health care industry, therefore, enhancing people's well-being and the quality of life" (seekingalpha ).
Accelerating Progress
Both tailwinds should continue in the coming months - and might even get stronger. When inflation continues the way south, following the pull of the shrinking money volume, and is getting closer to 2% - the skeptics will get silenced and the markets will get more optimistic. The rapid progress of AI - which seems to accelerate - should raise company revenues & profits in the coming quarters significantly, fueling further stock market gains.
Enjoy!
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